With global stock markets continuing their sickening plunge and the credit system all but shut down, efforts by the Federal Reserve, Treasury and global leaders have been overwhelmed by global panic.
The wide-ranging, unprecedented actions to cure the illness may yet prove effective. But until the fever breaks, fear has the upper hand.
"It feels like the blackest morning — I’m trembling," said Hugh Hendry, a partner at the U.K. hedge fund Eclectica.
“I question whether I have a future or whether any of my peer group has a future," he told CNBC. "We had a sense yesterday that the problem has become bigger than government, so now I struggle to tell you any solutions.”
Panic selling continued to pound stock markets Friday as investors dumped holdings, although there was a glimmer of hope in the final hour of U.S. trading. The Dow Jones industrial average, which had been down more than 600 points earlier, was down about 127 points, according to preliminary closing figures.
With share prices no longer based on individual companies’ business prospects, buyers have little to go on when trying to see the bottom. All week, waves of panic selling have been interrupted by erratic, unsustainable rallies.
"What everyone has to be asking these markets every day is: How much are you willing to look beyond the short term?” said Zachary Karabell, president of River Twice Research, an economic research and consulting firm. “Looking back in the past there is an ‘after’ to these moments. And it seems like in the moment, there isn't.”
The situation in the global credit market is no better; credit remains largely frozen. Banks and investors are hoarding cash, fearful that if they lend money, the borrower may not survive the crisis.
The Treasury and Federal Reserve have taken unprecedented steps to address the panic — pumping over $1 trillion into the banking system and moving to buy up troubled mortgage-backed securities.
Nobody else is willing to buy these investments — or make new loans — until it becomes clearer which banks will survive. With no market for mortgage-related securities, there’s no way of knowing the true value of trillions of dollars worth of assets that have blown a huge hole in the banking industry’s books. And nobody knows which banks have sustained the most damage.
The biggest plan to date, approved by Congress and signed into law last week by President Bush, is the Treasury’s proposal to spend up to $700 billion to buy these troubled assets. But officials are still working out the logistics involved in setting up a new, multitrillion-dollar market to provide investors the chance to bid on these investments and information on prices being paid as they begin changing hands.
“The Federal Reserve and central banks around the world have been starting to hit it hard, but most market participants have viewed them as being behind,” said Eugene Flood, an investment adviser at Smith Breeden. “Right now, the market is just cash-starved. And they have been putting a lot in, but we've got to realize this global financial system is very large. So hundreds of billions of dollars are needed on top of what has been done so far.”
No matter how much money the world’s central banks offer up, it won’t begin moving through the system again until bankers and investors begin to get some assurance that the person or company they lend to will pay them back. Short-term market-based interest rates set by private lenders, measured by a global index called the Libor, are more than three times as high as the rate targeted by the Federal Reserve.
“Right now it's a measure of trust between the banks,” said James Reed, a money manager at the UMB Scout Stock Fund. “It's continuing to move up, and that shows less and less trust in the system. That's what you have to restore, is trust. That's when you know you have a bottom, and that's when the (credit) markets finally loosen up a little bit. “
With so little trust among bankers, the Treasury may ultimately have to move to guarantee all lending between banks. That would help reduce the risk of lending again and help unfreeze the system.
To speed the creation of a market for mortgage-backed investments, some have suggested the Treasury turn to existing markets like commodities exchanges. The longer it takes to implement the plan, the further the markets and financial system will deteriorate.
The panic is also being fed by uncertainty about solutions being engineered less than a month away from an election that will bring a change in administrations. The response to the chaos of the global financial meltdown will be further complicated by the transition process, which normally takes several months.
All of which means the crisis will continue to require more creative, extraordinary measures.
“I think that this is a fixable problem — there are lot of things that will work if they have the will to do it,” said Richard Hoey, chief economist of the of Bank of New York Mellon. “Frankly, I think they're smart enough to figure it out. But that doesn't mean we won't have a recession for the next nine months.”
Much like estimating damage from a storm that’s still raging, it’s far too soon to predict how badly the global economy has been hurt. Early indications will be seen in a few weeks, when the government begins reporting economic data for October, beginning with the monthly employment data. While monthly job losses have been rising, they haven’t yet approached levels seen in deep recessions of the past.
A lot will depend on how consumers respond to the panic. The massive destruction of wealth in retirement savings, college funds and other accounts will almost certainly bring big cutbacks in consumer spending. After years of easy credit, consumers already are finding it much harder to borrow to fund their lifestyles. The resulting belt-tightening could end up hitting the economy even harder than the financial crisis now under way.